This article has been written by Surabhi Gupta, pursuing a Diploma in Cyber Law, FinTech Regulations and Technology Contracts from LawSikho and Raj Nandini, from Amity Law School, Noida.

Introduction

Cryptocurrency is a virtual or digital currency that is secured by cryptography that makes it almost impossible to double-spend or counterfeit. This word “cryptocurrency” is derived from the technique of encryption which is used for network security. Cryptocurrency is backed up by the participant’s belief in a marketplace that will retain its value. Most of the cryptocurrencies are decentralized networks based on blockchain technology- which is a decentralized, distributed ledger system wherein the transactions are recorded and verified via a peer-to-peer consensus mechanism. 

Background

Origins of the currency are traced way back in 1998 by a computer programmer named Wei Dai. He first proposed the concept of cryptocurrency and called it B-Money which was anonymously distributed through an electronic decentralized cash system. This concept was carried forward and finally given shape in 2009 by pseudonymous developer Satoshi Nakamoto the creator of the most widely accepted and the first decentralized Cryptocurrency known as Bitcoin.

Merriam-Webster’s dictionary defines Cryptocurrency as “Any form of currency that only exists digitally, that usually has no central issuing or regulating authority but instead uses a decentralized system to record transactions and manage the issuance of new units, and that relies on cryptography to prevent counterfeiting and fraudulent transactions.” 

Illustrations

A cryptocurrency or virtual currency is a digital asset which was designed to work as a medium of exchange, wherein the transaction records are recorded in a digital ledger. It does not exist in physical form as paper notes. It is not centralized which means that it is not issued by a central authority/government or central bank (for example in India, the currency is issued by the Reserve Bank of India). This feature of cryptocurrencies delivers them hypothetically resistant to government obstruction or control.

It works in a decentralized apparatus through distributed ledger technology, typically a blockchain, that serves as a public transaction database. The first cryptocurrency was released in 2009 which is known as Bitcoin. Today there are more than 6000 cryptocurrencies available.

They are digital representations of value and can be stored and transferred digitally. As the name itself suggests, cryptocurrencies work through the use of cryptography i.e. mathematical principles and computational practices which are used for storing and transmitting data. Some of the most popular cryptocurrencies are Bitcoin, Ethereum (ETH), Litecoin (LTC), Tezos (XTZ), Cardano (ADA), Monero (XMR), Chainlink (LINK) and XRP (Ripple).

Blockchain

Blockchain is one application of the distributed ledger technology (DLT) which is essentially used to maintain a decentralized database (that is ledger) and being a decentralized system, there is no central authority that tends to approve and maintain a record of the database. The value of the cryptocurrency is derived from demand supply, media forecasts and the work performed on coin mining. Unlike gold, which backs a relatively stable fiat currency, they are considered to be highly unpredictable with value making enormous deviations both negative and positive overnight. When attempting to regulate cryptocurrencies, taxation is a major obstacle. Many countries agree that cryptocurrencies should be taxed but are divided on whether as a currency or a commodity they are to be taxed. Another loophole that needs to be plugged is border taxes as the online ease of bringing the tokens through border checkpoints without border tax being paid indicates the need for a better framework both within and between countries.

The world’s first cryptocurrency was and it was one of the first applications of Blockchain technology that did not require its users to trust any central authority. Its underlying features such as reliability and distributed consensus made the business adopt this new technology. 

Purpose of cryptocurrency

Cryptocurrencies aim to make it easier for two parties to move funds directly without the need for a trusted third party, such as a bank or credit card company. Instead, the use of public keys and private keys and various types of reward schemes, such as Proof of Work or Proof of Stake, protect these transfers. The “wallet,” or account address, of a user has a public key in modern cryptocurrency systems, whereas the private key is only known to the owner and is used to sign transactions. Fund transfers are completed with minimal transaction costs, helping consumers to escape high fees paid for wire transfers by banks and financial institutions.

They are well suited for a variety of criminal activities, such as money laundering and tax evasion, due to the semi-anonymous existence of cryptocurrency transactions. Cryptocurrency proponents, however, also strongly value their anonymity, citing privacy advantages such as whistleblower protection or protestors living under oppressive regimes. More private than others, some cryptocurrencies are more private. For example, Bitcoin, due to the forensic analysis of the Bitcoin blockchain has allowed authorities to apprehend and convict offenders, is a comparatively poor option for conducting illicit business online. However, more privacy-oriented coins exist, such as Dash, Monero, or ZCash, which are much harder to trace. 

Regulations dealing with cryptocurrency

At present, cryptocurrencies are unregulated. Historically, RBI through its notification dated 6th April, 2018 entitled ‘Prohibition on Dealing in Virtual Currencies (VCs)’ (the ‘Crypto Ban Notification’) under Section 35A read with Section 36(1)(a) and Section 56 of the Banking Regulation Act, 1949 and Section 45JA and 45L of the Reserve Bank of India Act, 1934 (hereinafter, “RBI Act, 1934”) and Section 10(2) read with Section 18 of the Payment and Settlement Systems Act, 2007 imposed a ban on all banks and financial institutions from providing services to the transactions related to cryptocurrency and also to exist from any kind of relationships with such person or entities, who are already providing those services. Apart from this it also issued repeated warnings related to investing in it as well. Cryptocurrencies are ‘stateless digital currencies,’ according to the RBI, in which encryption methods are used for trading and they enjoy protection from state interference as these currencies function independently of a central bank. As a result, they may be commonly used to carry out illicit transactions. 

This effectively crippled the crypto industry because the banking service required exchanges to send and receive money to turn cash into cryptocurrency and pay wages, suppliers, office space, etc. Crypto users were forced to cash out quickly and, with the loss of both banking services and decreased transactions, the industry was hit hard on two fronts. 

Internet and Mobile Association of India v. Reserve Bank of India

The Internet and Mobile Association of India (IMAI) representing the interest of the online and digital services industry, on May 15 2018, in Internet and Mobile Association of India v. Reserve Bank of India, the industry body – whose representatives carried out cryptocurrency transactions among themselves, filed a written petition in the Supreme Court, seeking to overturn the RBI circular. They argued that cryptocurrency was more on a product’s lines and that the RBI did not have the authority and power to impose a ban.

On March 4th 2020, when the apex court adopted a decision in a well-conceived judgment, the situation completely changed, quashing the earlier ban imposed by the RBI. The Supreme Court applied the doctrine of proportionality before giving the decision in favor of cryptocurrency. The SC while deciding on the matter went through the Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019, which has only been proposed but not passed and stated that the intention of the legislature cannot be clearly understood from the Bill as on one hand, the country’s cryptocurrency users face criminal penalties, and certain activities such as mining, holding, selling, trading, issuance, disposal, or use of cryptocurrency are prohibited. The bill, on the other hand, cleared the way for the government to launch its own digital currency, the ‘Digital Rupee,’ which will be issued by the Central Bank.

The Court also noted that The Crypto-token Regulation Bill, 2018 originally recommended by the Inter-Ministerial Committee included proposals to: 

(i) prevent persons dealing with crypto tokens from falsely claiming that they are not securities or investment schemes, or offering investment schemes, due to loopholes in the current regulatory system, and 

(ii) control VC exchanges and brokers where sale and purchase may be permitted. The Inter-Ministerial Committee was fine with the concept of enabling the selling and purchase of a digital crypto asset at recognised exchanges, according to the key aspects of the Crypto-token Regulation Bill, 2018, contained in paragraph 13 of the ‘Note-precursor to text.’

With this, a sigh of relief was lifted by crypto traders and investors and the industry started to see steady growth again. But there, things didn’t stop. In 2019, notices were issued by tax authorities in India to the residents dealing in cryptocurrencies which contains a list of questions regarding the dealing in cryptocurrencies and on the income generated by cryptocurrencies by trading in cryptocurrencies which has not been reported in residents tax returns.  On June 12, news reports were announcing that by implementing a bill, the government plans to issue a permanent ban on cryptocurrencies. 

The point is that, in this respect, a law will be more successful than a circular by the RBI. A note was adopted by the Ministry of Finance for inter-ministerial consideration Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019 which would work for a while and then it will be introduced as a law in order to ban cryptocurrency effectively and decimate the industry. 

Under the Bill, cryptocurrency is defined as ‘any data, code, or token that has a digital value representation and is useful in a business operation, or acts as a value store or account unit’. The bill would effectively prohibit cryptocurrency mining, holding, selling, trade, issuance, disposal or use of cryptocurrency in the country. Other related economic offences are grossly disproportionate to the punishments prescribed under the bill. Mining, Holding, Selling, Trade, Issuance, Disposal or use of cryptocurrency is punishable by up to 10 years of imprisonment and is the same as money laundering offenses.

This Bill in short seeks to ban all private cryptocurrency in order to create a proper framework for official digital currency in India, which has a backing of the RBI and the government. It tends to also provide certain exceptions to promote the underlying digital currency driving technology.

Regulation of cryptocurrency trade

Since, cryptocurrency is an inalienable element of any state and because cryptocurrencies are invading this space, regulating cryptocurrency will require supervision from various authorities and heavy regulations such as:

1. RBI-for the purpose of regulating cryptocurrencies as a legal tender.
2. The Directorate of Enforcement- banning the use of cryptocurrency in case of economic offences.
3. Department of Economic affairs- for regulating cryptocurrencies’ interference in the economic policies of the state. 
4. SEBI- using cryptocurrencies in security contracts.
5. Tax authorities of India- Implications of tax with respect to trading in cryptocurrency. 

Hence, building a comprehensive framework for regulating every aspect of cryptocurrency trade seems to be a complicated task. The RBI may depend on the blockchain framework to make an administrative presence in the crypto space. It might likewise consider giving licenses to crypto trades which may just be given after a proper examination of records and in the wake of meeting important compliance requirements. 

Additionally, a structure inter alia providing for submission of exchange records to the RBI within a specified time span might be set up which won’t just guarantee safety of exchanges and limit unlawful use, but also helps in increasing protection of the consumers.

The profits gained from buying and selling cryptocurrencies may be taxed as capital gains by the tax authorities. The Securities and Exchange Board of India (SEBI) can also control the trading aspects of cryptocurrency transactions. This will increase traders’ morale because they will know that adequate due diligence is being done on crypto transactions, lowering the risk of embezzlement in such transactions. Additionally, businesses can sell initial coin offerings (like initial public offerings (IPOs)) from which they may be able to raise funds by issuing tokens in return for cryptocurrency. For customer and investor security, SEBI may control the entire process and create a refund mechanism if delivery fails.

Status in India

India is home to 130 million people and is expected to have a 34.33% share of youth in the total population by 2020. From 302 million users to roughly 635 million users in 2020, the number has more than doubled. This is a result of increased availability of cheap data plans along with various government initiatives under the Digital India campaign. With the mammoth increase of internet users, the use of cryptocurrency in India inevitably went up.

Still, until 2018 Indian government had no policy in relation with cryptocurrency except a few notices and press releases cautioning the public of the risks related to the use of cryptocurrencies. In absence of any policy/statute on cryptocurrencies, many companies dealing in cryptocurrencies came up. According to a study conducted by the Indonesian firm Pundi X, “about 1 in every 10 bitcoin transactions worldwide took place on the Indian subcontinent,” reported Quartz.

Also several cases and scams related to trading and investing in Cryptocurrency came to light out of which the most famous was the Gain Bitcoin Scam. ‘Gain Bitcoin’ was a company owned by Ajay Bhardwaj and Amit Bharadwaj. Under the umbrella of Gain Bitcoin, Bhardwaj created a multi-level marketing scheme. He had more than 100,000 investors who were promised 10% monthly returns but the returns failed. Bhardwaj has thus, has been held in the $300 Mn Bitcoin Ponzi Scheme under IPC Sections 406, 420, 34, 409, 120B, 109, MPID Act sec 3 and sec 4, and IT Act, Section 66B.

Finally, in the 2018-19 budgetary speech, the Hon’ble Finance Minister of India, Late Arun Jaitley, laid the issue to rest by announcing that ‘ the Government does not consider crypto-currencies legal tender or coin and will take all actions to prevent their use in funding illegitimate activities or as part of the payment system.’

Subsequently, the Reserve Bank of India issued a “Statement on Developmental and Regulatory Policies” on April 5, 2018, paragraph 13 of which directed the entities regulated by RBI –  

1. not to deal with or provide services to any individual or business entities dealing with or settling virtual currencies; and
2. to exit the relationship, if they already have one, with such individuals/business entities, dealing with or settling virtual currencies (VCs).

On April 06, 2018, a circular, said that financial institutions could no longer deal with entities that trade in virtual currencies such as Bitcoin. It stated that “Given the associated risks, it has been decided that, with immediate effect, entities regulated by RBI shall not deal with or provide services to any individual or business entities dealing with or settling”. These instructions were issued in exercise of powers conferred by section 35A read with section 36(1)(a) and section 56 of the Banking Regulation Act, 1949, section 45JA and 45L of the Reserve Bank of India Act, 1934 and Section 10(2) read with Section 18 of Payment and Settlement Systems Act, 2007.

In 2019, a petition has been filed by the Internet and Mobile Association of India with the Supreme Court of India testing the legality of cryptocurrencies and looking for a direction or order limiting their exchange. In March 2020, the Supreme Court of India passed the decision, denying the RBI restriction on cryptocurrency exchange.

Bitcoin trades are not astounded by this move. Praveen Kumar, director and CEO of Belfrics Global SDH, an organization that runs bitcoin trades in Singapore, Malaysia, Bahrain, Japan, Kenya, Nigeria, Tanzania and India said, “For the government to give the virtual currency a money status has a greater implication, particularly because of the capital controls we have here in India. In the event that they give it a status of currency, they need to permit us to run the trades here. On the off chance that they permit the trades, how are they going to control the progression of cash all through the nation? I was anticipating that this should occur,” said.

Conclusion

India’s cryptocurrency space will continue to remain unregulated, unless a proper regulatory framework is introduced. While the Supreme Court’s decision has given the crypto market a boost, and cryptocurrency start-ups in India are expanding and launching new products, there are some concerns due to reports that the finance ministry has floated a government bill for inter-ministerial consultations that could ban cryptocurrencies. Despite this, cryptocurrency start-ups are positive about the immense potential and future of cryptocurrency in India, and they are lobbying the government to avoid imposing a blanket ban.

References

1. https://www.cpajournal.com/2018/06/15/the-reality-of-virtual-currency/ 
2. https://www.investopedia.com/terms/c/cryptocurrency.asp 
3. http://www.legalserviceindia.com/legal/article-3135-regulation-of-cryptocurrency-in-india-in-contrast-to-india-s-proposed-final-ban-.html 
4. https://www.loc.gov/law/help/cryptocurrency/world-survey.php 
5. https://www.ibanet.org/Article/NewDetail.aspx?ArticleUid=2E4FB646-4FFD-4660-A5BE-5E41E79C5576 
6. https://economictimes.indiatimes.com/news/economy/policy/view-india-needs-legal-framework-for-cryptocurrencies/articleshow/74567416.cms?from=mdr 
7. https://www.lexology.com/library/detail.aspx?g=5cc1e39e-2bd5-45cf-a555-63b4e80ed52b 

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